The point of no return
Every action creates a reaction. In this particular case, the spark happened around 7 years ago. And the ripples are only but starting to affect us. Satoshi Nakamoto (SN), in 2008, proposed that currency should be detached from central governance. To achieve this, SN created something called the blockchain. It’s nothing more than a distributed global ledger across a network. In other words, it’s like when you open your bank records online. That’s the blockchain. The ledger of all your transactions. I highly advise anyone interested on the topic to read the original whitepaper (end of article).
Why was this specific moment so important? After all decentralized ledgers had been tried before (DigiCash for example). The beauty of this specific decentralized ledger called blockchain, is its own protocol. While past attempts still used some kind of centralization (ex: central servers, databases), the bockchain was the first truly decentralized ledger. It allowed people to anonymously send and receive currency, in the form of its own network E-currency Bitcoin, with transparency, security and reliability. Meaning, people can store a form of money, and transfer that money to other people, without going through a bank or a payments institution (like visa, or paypal). All is managed by the individual. This argument brings up two central questions that I quite often like to think about: (1) how do I, today, store and manage my own money? (2) Why do I accept currency which is controlled by a government or a central bank?
— Note: I’m not going to discuss the technical details of blockchain security, or how it could be “misappropriated” (hacked) by an evil agent. That’s for programmers, mathematicians and very smart people to do —
The distributed ledger technology did open our lives to a new possibility. Not only to transfer and store our own money, without going through a central institution, but to store other forms of value. See, new ways of thinking spawn new ways of thinking. Soon after the blockchain, other types of distributed ledgers started to appear. Ethereum is probably the most famous and important. For a good reason! It not only allows users to store money (in the form of its own currency, Ether) but also to create contracts and assets. It enables a new type of economy, where goods do not need to be centrally registered. A house can be a contract on the Ethereum network. And all transactions related to that contract can be seen and accessed at any time, by anyone. Even if your government would expropriate your land or your house, there would always be unchangeable proof that you own it — on the network, as no transaction can ever be deleted or changed by any party.
Because of these powerful new protocols that can serve as an open-source basis for new future governance methods, cryptoeconomics was truly born. In its essence, it explains how the decentralized economic model works. A very basic definition could be: cryptographic algorithms that have economic incentives. So far, the method to make the cryptoecomony work has been based on proof of work. Although it seems complicated, proof of work simply dictates that in order for a transfer to happen between you and me, someone else needs to approve that transaction. A third party’s computer system (or node) has to compete with other third party nodes (or miners), in order to solve blocks (these mathematical problems based on hashes) and get block rewards. These rewards are Bitcoin, on the blockchain; Ether in the Ethereum network. And so on. But is this the best method? A very straightforward argument explains that the more difficult the mathematical problem becomes to solve, the harder it gets to solve a block and get rewarded. More energy (gas) will be spent to allow your computer to solve the hashes, less money will be given per block (if the currency supply is limited), and fees can exponentially increase in the future. This is the (a) transaction cost problem — with more people using a distributed ledger that is based on proof of work, the more “controllers” you need to validate transactions and the more expensive it gets to solve each block. But that’s not the only issue. If you look at the block size, and the time it takes to approve each transaction, you see it still takes quite longer than “legacy” systems. This is the (b) scalability problem: how to make transactions faster to approve and add more transactions to each block? That is indeed possible by increasing the block size. But that is a short-term solution as you cannot continually to increase the block size infinitely.
This takes me to my last point. This distributed ledger technology is shifting to a new method of work, called proof of stake. The logic here is that if you want to validate transactions and get rewarded, you must bet a stake on the right transactions. It’s exactly what you’re thinking: you bet a stake, either the entirety or part of the money in your electronic wallet, on the transaction you believe will be the correct one. This disincentives evil behavior, as if you bet on the incorrect transaction, and it does not go into a block, you lose your stake, thus enabling the possibility of a fee less network, as coin holders become the controllers. There are more twists in both proof of work and proof of stake which i do not mention due to complexity. And there are other distributed protocols like the tangle (IOTA) where the distribution is not done in blocks, but in a kind of map (the DAG); you do not need to be in constant communication with the main network, as you can just do your own stuff offline (works with snapshots) and then re-connect with the main network at a later moment (perfect for machine-to-machine transactions and economy).
Do you see the economic web behind cryptocurrency? Bitcoin, ethereum and many other coins have a simple purpose: to allow people to trade and store assets (money or goods) in a decentralized network controlled by no one. Decentralized Applications (dAPPS) can be built on top of these networks (more specifically ethereum), that will enable a new type of commerce and governance to emerge. Decentralized organizations, where you can access your contract and cast your vote on a subject; decentralized governments, where you could enable people to create cryptoassets that hold their personal information (like a passport on the blockchain); those contracts could be accessed anytime by the owner and checked by emigration authorities from multiple countries. Decentralized asset holding, like a house, a car or a deed of some sorts, means that no one but yourself would have access to, but could still be seen and checked by all (due to the existence of public keys and private keys).
The more you understand distributed ledger technology, and how the economic incentives work, the more obvious it becomes: there is clearly a bright future ahead of us.
*this topic expresses my own views and opinion. If you disagree, have feedback, or would just like to comment, share your thoughts below*